Monetary Policy And The Equity Market

The projected decline in global growth from 5.7 % in 2021 to 2.9 % in 2022 is a sharp decline from the January projection of 4.1 %. Over the years 2023–2024, it is expected to maintain that pace as the conflict in Ukraine hampers trade, investment, and activity in the short term, pent-up demand declines, and accommodative fiscal and monetary policies are lifted. This depressing mood in the market caused several market giants to lose profits and fear the future to the extent that they are either holding new hiring or laying off their employees due to the global economic condition of a possibility of stagflation. Meta is accelerating its cost reduction policy by hiring only 6000 to 7000 new engineers in 2022 versus a prior plan of hiring 10,000 new employees, as well as ceasing hiring mid to senior-level positions. Coinbase (COIN) laid off more than 1000 employees, Robinhood (HOOD) laid off 9% of its staff and Tesla (TSLA) laid off 200 staff, Microsoft  (MSFT) also decreased its hiring targets, as well as, Amazon (AMZN) is also expected to cut its initial hiring targets. Furthermore, 59% of the S&P500 firms that have pre-announced their earnings showed negative results during June. Amazon published its first quarterly loss in almost seven years, Accenture Plc’s stock (ACN) fell 1.1% after the company revised its earnings forecast for the year due to mounting inflation, and Nike reported a loss of $790 million during the period ended May 31, compared to a net income of $989M year on year while revenues decreased by 38% compared to the same period in to reach $6.31B, total revenue decreased by 38% y-o-y to reach $6.31B from $10.18B.  Healthcare, consumer staples, real estate, and utilities are all viewed as safer investments in the stock market and they gained more than 1%, meanwhile energy stocks slipped 4.7% as crude prices sank USD 1 per barrel signaling a recession. Ahead of the Fed's 2022 stress test results, which will determine how much capital banks would need to weather a severe economic downturn, bank stocks fell, with Bank of America falling by 3.6 %.

Understanding the underlying factors influencing the performance of the stock market requires keeping track of how money is changed. The tables below demonstrate that, across the four areas, the Fed's prior relationship with Quantitative tightening only adequately explained 9% to 35% of the movement in 10-year bond yields, 1% to 23% for equities, and less than 5% for credit spreads overall. A weak association is shown by an R-squared of less than 70%. In the long run, the overall R-squared of coincident or forward returns across asset classes to central balance sheet changes is quite low. For example, a USD 100B change in the FED’s balance sheet was associated with a 55-bps gain in the S&P500 and explained just 2 bps of equity market variance. For the US Gov 10-year bonds, a change in the FED’s balance sheet was associated with a 12-bps gain in the Government 10-year bonds and explained 100 bps of the bonds’ variance. Therefore, over the last 13 years, a balance sheet change does not explain much of cross-asset performance.  


Cross-asset betas (coincident returns) to regional balance sheet changes (August 2009 to date)| Source: Financial Times, Bloomberg, Morgan Stanley Research

Cross-asset betas to US QT| Source: Financial Times, Bloomberg, Morgan Stanley Research


Global liquidity is still too high but it is dwindling given that there is a bearish sentiment looming on the US stock market, down 20% from its top in January. If we look at the past 11 S&P500 bear markets since WWII, we can see that the bear markets lasted up to 16 months on average and we have already foreseen a down move in the market since January. It will take time to recover all the losses in the market. The CBOE volatility index has not yet fallen to the lowest points that it did during previous recessions, where the decline lasted, on average, around 20 months. In a recession, GDP declines but the money supply does not instantly respond, which eventually leads to a drop in the velocity of money. For the same effect, a larger QT is required the more liquidity in the system. Additionally, the impact of liquidity on asset values evolves with time; however, It has typically gotten weaker as liquidity has increased in supply.






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